The Hidden Fractures Behind America’s “Resilient” Economy | Aahan Menon

Key Concepts

• Time Horizons in Economic Analysis: Distinguishing between intraday, weekly, and high-level macroeconomic views is crucial for understanding market pricing.
• Wealth and Asset Ownership Distribution: A significant problem exists in how wealth and assets are distributed, with affluent consumers driving most spending.
• AI Capex as Profit Juice: Capital expenditures on AI are currently a strong driver of corporate profits due to the lag in depreciation expense recognition.
• Nominal vs. Real Growth: Understanding the difference is vital, as nominal growth can flow directly to profits even with weak real growth, impacting different markets differently.
• Monetary Policy Transmission: The effectiveness of the Fed's policy rate changes is hampered by the large amount of Treasuries held by the private sector.
• Liquidity Frameworks vs. Measures: While liquidity is a useful concept, many common measures (like the Fed's balance sheet) are lagging and less useful for trading than market-based indicators.
• Edge in Macro Trading: True edge lies in short-term, dynamic risk management and adjusting views as odds change, not in predicting long-term economic outcomes.
• Diversification and Risk Management: Basic principles like diversification, volatility targeting, and trend following offer significant value for individual investors.

Economic Outlook and Market Implications

High-Level Economic Picture

The current economic landscape is characterized by strong nominal spending, driven by a resilient consumer and significant AI-related capital expenditures (capex). However, beneath the surface, there are notable divergences. While aggregate numbers suggest expansion, growth is increasingly concentrated among affluent consumers and businesses investing in AI. Traditional companies are not undertaking similar levels of investment.

• Nominal Spending: Estimated to be between 4-5%, depending on the measurement speed.
• AI Capex: A significant driver of current investment and business cycle stimulation.
• Consumer Spending: Remains robust, particularly from affluent segments.
• Divergences: Growing gap between labor and spending, and between affluent and other consumer groups.

Consumption Dynamics: Income vs. Wealth

The sustained consumer spending, even when savings rates appear low, is attributed to a wealth distribution problem and asset ownership concentration. Affluent individuals with larger cash balances and access to capital gains are fueling consumption, rather than relying solely on income.

• Savings Rate Limitations: The savings rate is an income statement concept and doesn't fully capture spending fueled by balance sheet drawdowns (cash, earnings, leverage, or capital gains).
• Balance Sheet Concepts: Spending in excess of labor trends is increasingly coming from wealth, not just income.
• Nominal vs. Real Spending: Black Friday sales figures show nominal growth (e.g., 9% year-over-year) but declining volumes, indicating that nominal revenue growth can mask real consumption weakness.

Implications for Markets: Equities and Bonds

The distinction between nominal and real growth has significant implications for different asset classes.

• Equities: Nominal growth directly flows to corporate revenues. If wages do not rise proportionally, this translates into higher profits. The traditional correlation between real GDP growth and corporate profits has weakened due to this dynamic.
  • Argument: "The nominal growth dynamic basically flows straight through to corporate revenues... the residual ends up being profits."
• Bonds: Bond market performance is primarily driven by the trade-off between growth and inflation (unemployment and measured inflation) and the Federal Reserve's reaction function.
  • Scenario: If real consumption expenditures decline while nominal revenue growth remains strong, leading to good corporate earnings, this traditional recession playbook for buying long bonds may not be useful.
  • Fed's Dilemma: When inflation is above target and employment is weakening, the Fed faces a difficult choice, leading to market whipsaws as expectations for monetary policy shift.
  • Data Point: Short-term mean reversion in bonds has shown a sharp ratio of approximately 1.9 this year, indicating market uncertainty and lack of a defined trend.

AI Capex and the Business Cycle

AI capex is currently a significant stimulative factor for the business cycle and corporate profits.

• K-Levy Equation Framework: This macroeconomic identity, which relates GDP and GDI to profits, helps model the drivers of profits.
• Profit Juice Mechanism: Gross investment, including AI capex, contributes directly to revenue. The associated cost (depreciation) is recognized over time, creating a significant profit boost in the short term.
  • Explanation: "The thing that's unique about not just AI capex... but all gross investment in GDP is that the associated cost with gross investment isn't recognized today. It's recognized in the future in the form of depreciation expense."
• Sustainability Concerns: While AI capex is currently beneficial, its sustainability is questioned due to financing needs and the eventual need for recomposition from investment to consumption spending.
• Long-Term Outlook: The speaker is a "non-believer in AI just being this absolutely transformative thing which takes us to 6% real GDP growth a year," suggesting a more tempered long-term view.
• Actionable Insight: "Don't fight the profit juice" while capex is ongoing.
• Tracking Sustainability: The inflection point for sustainability will be when depreciation schedules begin to catch up with the build-out. Monitoring gross investment numbers, particularly AI capex, is key.
• Sectoral Divergence: While AI capex props up aggregate gross investment, other sectors like residential investment, construction, and industrial equipment spending are declining.

Government Spending and Net Interest Payments

The speaker holds an outlier view on the direct impact of government spending on aggregate GDP growth.

• Direct GDP Contribution: Government spending accounts for a relatively small portion of aggregate GDP growth (e.g., 0.3% when GDP is running at 2%). This is due to netting out tax revenues.
• Net Interest Payments: This channel is considered highly meaningful.
  • Mechanism: The significant expansion of the government balance sheet post-COVID led to a large inflow of Treasuries into private balance sheets.
  • Impact on Monetary Policy Transmission: When interest rates rise, holders of short-term Treasuries receive immediate interest benefits. This has reduced the effectiveness of the Fed's monetary policy transmission, as net interest burdens for the private sector have not risen proportionally with policy rate hikes.
  • Quote: "What we've actually seen is, you know, they hyped policy rates and net interest burdens went down like it like it like broke and their mortgages are fixed and then their income is going up like Exactly."
  • Conclusion: The recomposition of balance sheets and the broken monetary policy transmission mechanism are significant, reducing the Fed's ability to tighten meaningfully.

Liquidity and Monetary Policy Transmission

The concept of liquidity is valuable, but many commonly used measures are lagging and less useful for trading.

• Framework vs. Measures: A framework around liquidity is useful, but measures need careful evaluation.
• Fed's Balance Sheet: Changes in the Fed's balance sheet and reserves are often too slow to be actionable for trading.
• Repo Market: Tracking repo market volumes is more indicative of private sector borrowing and lending activity.
• Market-Based Indicators: The true "symptoms" of liquidity conditions are found in market-based indicators such as SOFR spreads, commercial paper spreads, implied volatility across assets, and credit spreads. These provide daily insights into dealer health and leverage.
• Actionable Approach: Reconstruct liquidity conditions using market-based symptoms rather than relying solely on slow-moving balance sheet data.

The Concept of Edge in Macro Trading

True edge in macro trading lies in short-term, dynamic risk management and adapting to changing odds, not in predicting long-term economic outcomes.

• Uselessness of Long-Term Predictions: Knowing where the economy will be 6-12 months from now is "completely useless for trading markets." Even perfect long-term predictions, without dynamic risk adjustment, can lead to underperformance.
• Mismatch in Horizons: A significant mismatch exists between the long forecast horizon of macro commentary and the short trading horizon (daily, weekly, monthly).
• Value of Risk Management: The real value in money management is in reducing risk around a view and adjusting the portfolio as odds change. This is where tangible monetary value lies.
• Prometheus Macro's Approach: They offer "pay for portfolios, don't pay for content," emphasizing that long-term macro content has limited monetary value.
• For the Average Listener:
  • Low-Hanging Fruit:
    • Diversification: Implement actual diversification in portfolios.
    • Leveraged Diversification: Utilize tools to lever diversification for better risk-adjusted returns.
    • Volatility Targeting: Tailor asset exposure to a specific volatility target (e.g., 10-15% volatility).
    • Basic Trend Following: Employ simple moving averages to cut off market tails.
  • Realistic Expectations: Avoid the trap of seeking a perfect portfolio that smashes the S&P with minimal drawdowns, as this is extremely difficult.
  • Time Commitment: Achieving outperformance beyond passive exposure requires significant time and energy, or paying management fees to skilled hedge fund managers.
• Cautionary Note: "Most things are going to underperform passive exposure."

Conclusion and Takeaways

The discussion highlights that while broad macroeconomic trends are important for context, actionable trading insights are found in shorter-term dynamics and sophisticated risk management. The current economy is experiencing strong nominal growth driven by AI capex and consumer spending, but with underlying divergences. The effectiveness of monetary policy is compromised by balance sheet structures, and true trading edge comes from dynamic risk adjustment rather than long-term economic forecasting. For individual investors, focusing on basic diversification, volatility targeting, and trend following offers significant value. The industry's tendency to oversimplify complex institutional strategies for retail investors is cautioned against.

Where to find Aan from Prometheus Macro:

• Twitter: @AanPrometheus
• Research Websites: Prometheus-research.com or Prometheus-macro.com
• Substack: Prometheus Macro
• Institutional Inquiries: Contact via email listed on their websites.